At some point in your life, you probably heard that the stock market generates about 10% annual returns on average. Sounds pretty good, doesn’t it. From 1926 to 2020, the average return for the U.S. stock market was basically 10% per year. Would it not be great if you could simply rely on this 10% return to be dutifully delivered every year? While that may be true in the long run, the market rarely delivers anything close to an average return in a given year. Understanding and being prepared for the broad manifestation in stock market returns is a big part of learning how to exercise discipline in investment. Consider the chart below from Ritholtz Wealth Management’s Ben Carlson. It plots the S&P 500’s annual returns since 1926.
Returns are widely distributed. There is no cluster around an average. It varies greatly from one year to the next. Returns are all over the place with zero consistency. You cannot predict what will happen next year. The illusion of certainty is easy to sell but impossible to deliver. But this volatility of return is the very reason why you receive excess returns in the equity markets over time. Take away the risk and you dilute the return. Volatility is not a penalty but rather the price you pay for greater return expectations.
Ben Carlson suggests that we cannot escape this risk, just change how we accept it. We experienced positive markets over the period above 74% of the time. 72% of the time we saw double digit gains or losses. 59% of the time were double digit gains and 13% of the time double digit losses. Equity market returns are lumpy. If you do not have a long-term perspective and understanding of how the market get’s to this long-term average you are bound to fall prey to all the bad behaviours that ends up working against you reaching your stated goals and objectives. Thinking and acting for the long-term requires better understanding and acceptance of reality. Markets being volatile is not new and is perfectly normal. it is to be expected.
What about local assets?
For the period 1996 to 2021 the FTSE JSE All Share (Total Return) Index Calendar Year Returns delivered an average return of +15,36%.
The black line represents the average return for the period. In 26 calendar year returns the average was experienced (nearly) only once in 2003. For the rest of the period, the calendar year returns either over-or undershoot the average at times by some margin. Bottom line – don’t expect the average every year.
Will an asset class with less volatility than equities provide a different experience? The equity market is more volatile than the bond market, so is it a reasonable expectation that investors could experience the average return with greater regularity?
To the right is the calendar year return profile of the FTSE All Bond (Total Return) Index from 2001 to 2021
The average return for this period was 10,04%. Although the average return was experienced nearly 4 times over these 21 years, it is still evident that this represents less than 20% of the time. For the rest, we similarly see that the calendar year returns over- and undershoot the average.
Summing it up It feels counter-intuitive, but the key takeaways are:
1. Temper your enthusiasm during good times.
2. Become more optimistic when things look bad.
3. You get the average return only if you buy and hold.
Earning the average long-term returns that the market offers requires an ability to stay in your seat. Because we don’t know when the big up years will come, we have to sit through the down years. But over time, we’ll earn what the market offers.
The “average” return publicised in the glossy pamphlets is just a mathematical construct. Rarely, as we have seen, does the market deliver an “average” return from one year to the next. The return that counts for you is the one that matches your time horizon.
The above article was written by Marius Kilian.